Please note, the case for Scottish independence is taking a pounding

No one should doubt that an independent Scotland would be economically viable.
But whether it would be desirable is another matter

If Scotland became independent and the Westminster government refused to allow Scotland to have a monetary union with the rest of the UK, as all three main parties have now said, the Scottish government would face three options.Photo: AP

The issue of Scottish independence has now entered a critical phase centred on the currency question. Rightly. For sovereignty and money go together.

We saw the importance of this link in the financial crisis when governments, including the British one, effectively gave guarantees to private-sector deposits and shored up private financial institutions.

And we have also seen it in the evolution of the euro crisis. Among the economists who studied the issue, the conventional wisdom was always that to work effectively monetary union had to be combined with fiscal union. And since money is at the very heart of sovereignty, fiscal union implies some sort of political union.

Yet when the euro was established there was no fiscal or political union to go alongside the monetary one. And no banking union either. The result is that the euro has been hanging by a thread.

Now it is widely recognised in Europe that ensuring the survival of the euro requires a fiscal and political union. So it is surprising that on Europe’s northern fringes, the SNP has been proposing a currency union while actually asserting fiscal and political independence. This would be a case of having your Dundee cake and eating it.

If Scotland became independent and the Westminster government refused to allow Scotland to have a monetary union with the rest of the UK, as all three main parties have now said, the Scottish government would face three options. The first is to have its own independent currency. I can even suggest a name – the salmond.

The salmond would be open to significant fluctuations on the exchanges and this could cause great uncertainty. If, as seems likely, the salmond fell sharply against the pound this would give Scottish industry a competitive boost, but Scottish debt denominated in sterling would now be more onerous in terms of salmonds.

The result could be financial chaos. And as investors would demand a premium to hold Scottish debt, long-term Scottish interest rates would be high.

The second option would be to join the euro. At first, this must have been Alex Salmond’s preferred option – although it would imply that no sooner had Edinburgh wrested fiscal and political authority from London than it would be handing it over to Brussels and Frankfurt.

But this option became much less attractive when the euro crisis broke. Presumably, Scotland would find itself liable for its fair share of whatever bail-outs and goodies were tossed to the peripheral euro members to prevent them from imploding.

Interestingly, as things stand, any country seeking to join the EU must plan also to join the euro. So Salmond’s only choice might be to be up for joining the EU and the euro, or to accept that an independent Scotland would sit outside both the euro and the EU. Anyway, he knows that the canny Scottish people simply would not take to the idea of joining the euro.

The third option is to continue to use the pound unilaterally, without the agreement of the rest of the UK. There are two variants of this. The first is to actually use pounds, just as Panama uses US dollars.

The second, more sophisticated, version, is to issue your own currency but to tie it firmly to pounds. This is the “currency board” system Hong Kong operates against the US dollar.

The monetary authority of Scotland would have to hold huge reserves of sterling against its issue of salmonds and it would have to be prepared to hand over pounds for salmonds at whatever the fixed exchange rate was – without limit.

As long as the market believed in this fixed link, it would bring stability. But Scotland would have no say in the setting of UK interest rates, which it would have to follow slavishly. And it would have no lender of last resort support from the Bank of England.

Then there is the issue of taxpayers in the rest of the UK picking up the tab for failed banks. Why should they? The UK government would surely only agree to this if there were firm curbs on both Scottish fiscal policy and bank behaviour. Yet these would surely run into opposition from the Scots as effectively restricting independence.

But even if they agreed to such restrictions, how would it be possible to enforce them on an independent Scotland? After all, when France and Germany broke the Stability and Growth Pact, no sanctions were applied. Hence the three main Westminster parties rejecting the idea of a shared currency.

Yet Scottish financial institutions are very large and they have a substantial amount of their business in the rest of the UK. If it was clear that the UK would not stand behind them in the event of trouble, then these institutions would probably find it difficult to continue to operate from Scotland at anything like their current size. They would lose retail business and would pay a premium for finance.

The result would surely be some sort of exodus of financial business from Scotland, with most of it probably going to London. Since finance, along with North Sea oil and whisky, is supposed to be one of its three pillars, this would be a serious blow to the Scottish economy.

No one should doubt that an independent Scotland would be economically viable. But whether it would be desirable is another matter – economically, politically and from the point of view of security. With an economy roughly the same size as Scotland’s, Singapore has managed to achieve great prosperity from an unpromising start.

Interestingly, she operates her own currency, the Singapore dollar, with considerable success. But then she does most things with considerable success. Would an independent Scotland manage as well? As they say in the northern part of the United Kingdom: “Ah hae ma doots.”